The U.S. Automotive Industry - An Analysis Based on Porter’s Five Forces Model

The U.S. Automotive Industry –
An Analysis Based on Porter’s Five Forces Model
Jason Ruby
ECON600
American Military University







Executive Summary
This analysis of the U.S. automotive industry has been conducted based on Michael Porter’s Five Forces Model, and focuses primarily on the three major American manufacturing companies – Ford, General Motors, and Chrysler. The U.S automotive industry is a huge facet of the American economy, with a historical average of 20% of U.S manufacturing resources tied to automotive manufacturing, supplies, and logistics. While these three corporate giants have been the traditional backbone of the U.S automotive market, globalization has blurred the line between what may be considered foreign and domestic companies. The analysis here will demonstrate how intense rivalry, competition, barriers to market entry, and the influence of power or buyers and sellers all impact this dynamic American industry.
This report also describes the early development of the U.S automotive industry in the late 1800’s through early 1900’s, gives an overview of its current state, and provides an outlook for the future. The primary focus is on the growth and development of Ford, General Motors, and Chrysler and how they reached their current status as among the largest automakers in the world. This report also discusses the impact of the global economic recession on these companies and in turn the impact on the U.S economy as a whole. The reasons for the $25 billion bailout are addressed, as well as how “The Big Three” were able to use this funding to restructure their organizations and recovery from near bankruptcy. The report concludes by explaining the trend by all major automakers toward globalization into the growing economies of Asia and South America.



The history of the automobile did not begin with gasoline-powered engines in the late 19th Century, as many people have come to believe. Rather, the first self-propelled vehicle designed for transportation on roads was a steam-powered invention by French engineer and mechanic Nicholas Joseph Cugnot in 1769. In fact, the roots of this invention date back much father, as both Leonardo da Vinci and Isaac Newton both has designs that inspired Cugnot. In the 1820’s and 30’s, several inventors in Hungary, Holland, Scotland, and the U.S. built the first electric automobiles, though it is not clear who’s design was actually the first. In 1842, non-reusable batteries were first used, but their short life span made electric cars impractical.
The history of the automobile industry, and the automobile markets themselves, began with the wide-spread use of gasoline-powered internal combustion engines in the 1880’s. In 1885, German engineer Karl Benz designed and built the first gas-powered internal combustion engine that was practice for use in automobiles. The first commercial producers of automobiles were French partners Rene Panhard and Emile Levassor in 1890. The automotive industry began in the United States in 1893 when brothers Charles and Frank Duryea established the Duryea Motor Company, and by 1896 “had sold thirteen models of the Duryea, an expensive limousine, which remained in production into the 1920s” (About.com, 2011).
Mass-production of American automobiles began with Ransom Eil Old’s design, the Oldsmobile, selling more than 2000 in 1902 and 5000 by 1904. These early cars had very simple designs, like motorized carts or horse carriages, and were very slow. Over the next decades, new modifications like the steering while, shock absorbers, and electric starters became standard features. Despite these innovations, automobiles were expensive luxuries that were far out of reach of the average citizen during this period, compounded by the drain on manpower and natural resources during World War I. In addition, maintenance and reliability problems plagued early automobile designs. Axles and shocks could not stand up to extended use and poor road conditions, and “cylinder heads had to be removed to dig carbon out of the chambers, and oil sludge could be scooped out of crankcases by the handful” (Motorera.com, 2011).
Although mass-production of automobiles began with the Oldsmobile in 1904, the first effective assembly-line was not developed until 1913 by Henry Ford. Mr. Ford began established the Ford Motor Company in 1903, and first began producing the legendary Model T in 1908. Although the Model T was not the most reliable or innovative car available in its time, it was by far the most produced and the best-selling, making the Ford Motor Company the first automotive industry giant. The reason for Henry Ford’s success was his use of assembly lines, the use of standardized parts, and division of labor at his production facilities, enabling economies of scale. Model T’s were cheap and easy to produce in large quantities, making them affordable to the average citizen in the United States and elsewhere.
By 1918, half of all automobiles being produced in the United States were Ford Motor Company’s Model T’s. To meet this growing demand, Henry Ford began work on a huge new factory complex in Dearborn, Michigan I the late 1918 which was eventually completed in 1927. This sprawling complex on the Rouge River, the largest in the world, was nearly seven million square feet and employed over 80,000 workers. Most importantly, Ford was able to build on his proven assembly line techniques and even greater economies of scale to reduce costs and generate greater profits. Not only were parts standardized, and assembled by workers who stayed at the same station, but the Rouge River factory, “included all the elements needed for automobile production: a steel mill, glass factory, and automobile assembly line” (Hfmgv.org, 2003).
By 1920, several new companies had been established to take advantage of the new and growing market for automobiles – General Motors, Chevrolet, Chrysler, Lincoln, and Dodge. Mergers soon followed, with General Motors acquiring Chevrolet in 1918, the luxury car manufacturer Lincoln acquired by Ford in 1922, and the purchase of Dodge by the Chrysler Corporation in 1927. While Ford continued to focus primarily on the production and sale of the Model T, General Motors “adopted a new production strategy for providing greater product variety, which helped the company increase their market share by 20% and reduce Ford’s by 24%” (Gatech.edu, 2006). The other large American manufacturers later followed suite, including Ford, taking advantage of acquisitions to produce new models like the Dodge Six and Ford Mercury.
After the end of World War II, automotive factories that had been converted to support the war effort returned to the commercial production. With the industrial infrastructures of Germany and Japan in ruins, and American industrial capacity at its peak, the U.S. automotive industry established itself as the world’s leader. Ford Motor Company, the Chrysler Corporation, and General Motors, or “The Big Three”, held the largest market shares and continued to acquire smaller companies. Dozens of smaller companies like Jeep, Mercury, Continental, and DeSoto were absorbed by the big three U.S automakers, enabling increased product diversification and brand recognition. President Dwight Eisenhower signed Federal-Aid Highway Act into law in 1956, establishing the U.S interstate system and the Federal Highway Administration, and the U.S. automotive industry continued to thrive throughout the 1950s and 60s (fhwa.dot.gov, 2011).

The American automotive industry faced a significant challenge in 1973 when the primarily Arab Organization of Petroleum Exporting Countries (OPEC) banned petroleum exports to the United States in response to its support of Israel in the Yom Kippur War. Manufacturers and consumers alike were faced with the realization that the U.S automotive industry, and in fact its entire industrial infrastructure, was particularly vulnerable to oil shortages. Until the 1970’s, American cars had been manufactured with little regard to fuel efficiency. Typical models by Ford, Chrysler, and GM were large, steel framed designs that took advantages of the wide American road systems. But by the mid-1970’s, the OPEC embargo “marked the beginning of the decline of the American auto industry, as Japanese firms associated with smaller cars grew rapidly” (american-business.org, 2010).
Throughout the 1980s and 90s, many automotive companies adapted their business models to those used by the Japanese, including “Just in Time” production, but in 2008 faced their greatest challenge to date with the global economic downturn. Many factors contributed to global economic downturn, which began with the collapse of the U.S housing market and cascaded into the banking and automotive industries. The “Big Three” U.S automakers had already experienced a decline in market share from 70% in 1998 to 53% in 2008, giving ground to companies in Europe and Asia. The global-scale recession in 2009 greatly reduced demand, particularly for traditional gas-powered automobiles, and the banking crisis made it difficult for companies to secure loans. At the same time, labor costs had reached record highs, with salaries, benefits, and health care costs increasing dramatically.

By mid-2008, “The Big Three” were all on the verge of bankruptcy without the intervention of the U.S government. Gas prices had risen to more than four dollars a gallon, and the large American SUVs that had been popular until this time were now sitting unsold on lots across the country. U.S automakers had failed to keep pace with Japanese automakers that had shifted their focus to smaller, more fuel efficient cars, and more recently to hybrid electric models. As a result, the American automotive industry was impacted more heavily than their overseas rivals. Many economists and leaders recognized the severity of situation, with automakers accounting for 2.3% of U.S economic output in 2008, down from 5% in 1999, and “20% of the entire national manufacturing sector is still tied to the automobile industry” (aaat.com, 2011).
In October of 2008, the U.S. Senate approved a 700 billion dollar bank bailout fund, and allocated 24.9 billion dollars to Chrysler, and General Motors to prevent the imminent collapse of the American automotive industry. The Ford Motor Company did not receive funds from the federal bailout package, but rather requested a 9 billion dollar line of credit from the U.S government and a 5 billion dollar loan from the U.S Department of Energy. These loans to “The Big Three” were intended to allow for alignment of resources and production facilities to produce more fuel-efficient and hybrid models. GM and Chrysler both pledged to streamline operations and introduce electric vehicle, while Ford “accelerate development of hybrid and battery-powered vehicles, retool plants to increase production of smaller cars, close dealerships, and sell Volvo” (USEconomy.about.com, 2011).
In 2011, the automotive industry in the United States faces significant challenges. Increased globalization, high oil prices and operations costs, and pressure to produce viable hybrid and electric models that are affordable to American consumers in a faltering economy are just some of the hurdles. For the CEOs, senior leaders, and strategic planners in these organizations, it is critical to examine the current state and dynamics of the U.S automotive industry, and to predict future trends, to be profitable and to prevent future crises. In 1979, Michael Porter of the Harvard School of Business introduced a method of analysis and business development strategy termed “Porter’s Five Forces Model”. Along with SWOT analysis (Strengths, Weaknesses, Opportunities, Threats), Porter’s Five Forces Model is the current standard for industry analysis and estimating the viability of entering or continuing to operate in given market.
Before an effective assessment of the U.S. automotive industry may be conducted, it is important to define the key aspects of the industry itself. First, the market structure of automotive industry is considered an oligopoly, in which a small number of companies dominate the market. In the United States, this oligopoly is comprised of “The Big Three”, while the key players outside the U.S are Honda and Toyota. Production and distribution of automobiles requires major investments in facilities, transportation, technologies, research and development, raw materials, and labor. Suppliers play a significant role is the automotive industry, supplying all types of components, including aluminum, steel, tires, and increasingly advanced electronics. Automakers release monthly sales reports are key indicators when analyzing market trends, as are inventory levels.
The first of Porter’s Five Forces is “The Bargaining Power of Buyers”. In an analysis of the American automotive, the bargaining power of the consumer, or buyer, is somewhat limited. The United States is a large country, and the contiguous 48 states are covered with an extensive highway system. Alternative such as public transportation is limited to the large urban centers, making private automobiles a necessity for most American citizens. In addition, the oligopoly created by having only three major manufacturers in the U.S results in many consumers having only a few purchasing options. Because of this, a consumer may bargain with a car dealer and reduce their cost a small percentage, but this amount is usually factored into the dealer’s sticker price in anticipation. Over the past few decades, however, consumers have been empowered by websites that help locate the lowest price without the need to haggle, and sites like eBay and Craig’s List eliminate the need for the dealership altogether.
The second of Porter’s Five Forces is “Bargaining Power of Suppliers”. Nearly every town in America has some type of car dealership, with the number being relative to population and in some cases the income of the customer base. These suppliers rely very heavily on the major automotive manufacturers to provide their inventory of new cars and trucks. Dealerships are under great pressure to maintain good relationships with “The Big Three”, which results in a similar situation as buyers where there is little power of influence. Another form of supplier in this market are those that provide the components of automobiles, like fenders, seats, tires, navigation systems, etc. Here again, the few number of manufacturers, or buyers, greatly influence price and quantity, limiting the power of these suppliers.
The third of Porter’s Five Forces, the “Intensity of Competitive Rivalry”, may be considered the most dynamic of the five. There is intense rivalry among the major U.S automakers, and in fact between all major manufacturers including those in Europe and Japan. With overseas companies opening facilities on U.S. soil and taking U.S market share, this rivalry is increasing. The result is huge investments in advertising, so much so that it has become part of the fabric of American media. In addition, the “degree of rivalry in the automotive industry is further heightened by high fixed costs associated with manufacturing cars and trucks and the low switching costs for consumers when buying different makes and models” (Gatech.edu, 2006).
The fourth of Porter’s Five Forces is “Threat of New Entrants”. Based on the Wall Street Journal’s year-to-date report on sales and market share of the automotive industry, “The Big Three” are the world leaders, with General Motors holding approximately 20% of market share, Ford holding 16.8%, and Chrysler with 12.1%. Small U.S. automakers like Tesla and Commuter hold less that 1% of market share, and larger, more successful automakers like Jeep, Ram, and Saturn being absorbed into “The Big Three” to be distributed as branded models. For a new automotive manufacturer to reach the level of production that would make the company a desirable acquisition option for General Motors, Chrysler, or Ford, there are very significant challenges (Wsj.com, 2011).
In fact, to even enter the automotive manufacturing industry in nearly impossible, with extremely high “barriers to entry” being a defining characteristic of an oligopoly. Automobiles are expensive to manufacture, with very high costs associated with production facilities, suppliers, logistics, and labor. The result is that global automotive industry experiences more mergers than new entrants. However, over the last few decades the trend has been for automakers to open production facilities in overseas markets. For example, Toyota and Honda have large production facilities in the United States. Toyota Motor Sales USA, Inc. currently holds the fourth largest share of global automotive sales with 15.3%, an increase of 2.8% from 2010. The American Honda Motor Company holds 10.2% with an increase of 1.2%, the fifth largest share of the global automotive market (wsj.com, 2011).
The last of Porter’s Five Forces is “Threat of Substitutes”. In the context of the automotive industry, substitutes may take the form of choosing a car or truck from a different manufacturer, or the potential customer that choose to use buses, trains, or airplanes. The purchase of an automobile is a major financial decision for most consumers, second only to purchasing a home or other larger ticket item. In metropolitan areas where public transportation is efficient and readily available, this is a strong alternative to owning a car. This is not an option for large parts of the United States, however. High gas prices and ongoing maintenance costs are the primary considerations when purchasing a vehicle, resulting in high demand for reliable, fuel-efficient cars and trucks.
In addition to the costs involved in purchasing and maintaining an automobile, marketing, branding, and customer loyalty are all important influences when evaluating the threat of substitute products or services. For example, many Americans continue to purchase less fuel efficient vehicles like trucks and SUVs despite the availability of alternatives. Loyalty to a manufacturer like Ford make compel some consumers to purchase a Ford Explorer over the smaller Honda CRV, and the desire to own a luxury brand name helps drive sales luxury SUVs like the Lincoln Navigator. Increasingly, customers are drawn toward new designs that incorporate technological innovations. All major automotive manufactures invest heavily in marketing and advertising in order to reinforce these influences, particularly through television commercials and Internet advertisements.
It is widely agreed that the combined $34 billion bailout and loans of “The Big Three” by the U.S. federal government in 2008 saved these companies from bankruptcy. While many believed these companies should have been left to fail, the cumulative losses to American GDP and the effect on the unemployment rate may have been catastrophic for the U.S economy that was already reeling. With these funds, GM, Ford, and Chrysler launched extensive restructuring efforts to focus on cheaper, more fuel-efficient vehicles and on more centralized production techniques. U.S. automakers “have started to reduce the number of technological platforms with a greater diversity of models produced from each platform in order to remain cost competitive” (Zacks.com, 2011).
Thanks to the U.S government bailout and subsequent restructuring, “The Big Three” of General Motors, Ford, and Chrysler are now each turning a profit. Between September, 2010 to September 2011, General Motors experienced an increase in total sales of 19%, while Chrysler saw a 27.2% increase, and Ford had an increase of 9%. Of the domestic line of cars and trucks produced by “The Big Three”, only Ford posted a decrease in sales of its cars, but did report an 18.2% increase in light truck sales. During the same period, General Motors increased its global market share from 18% to 20%, while Ford increased their market share from 16.6% to 16.8%, and Chrysler increased their market share from 10.4% to 10.6%. (wjs.com, 2011).
The future outlook for the U.S automotive market is a similar strategy that Japanese automakers have been following for several years by relocating production facilities overseas. The benefits of this strategy are two-fold. First, countries like China, India, and several in South America provide large workforces and cheap labor relative to the high costs of the salaries and benefits expected in the United States. Second, these countries are experiencing radical growth in population and in the sale of automobiles. For example, “China and South America together are projected to represent more than 50% of growth in global light vehicle production from 2008 to 2015” (Zacks.com, 2011). Moving manufacturing to these regions reduces the logistical costs of shipping cars and trucks overseas, and positions “The Big Three” to take advantage of these emerging automotive markets.


References
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